Adventures with consumer lending, Missouri edition

wrote last month about payday lending in Missouri, I posed two questions to Stand Up Missouri, a lobbying group representing loan shops opposed to a 36% cap on interest rates in the state. "
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When I wrote last month about payday lending in Missouri, I posed two questions to Stand Up Missouri, a lobbying group representing loan shops opposed to a 36% cap on interest rates in the state.

The first was with regard to a video on their site, where a college professor explains that when she approached her local credit union for a loan, they told her that her credit wasn’t good enough, and that she should go to a loan company instead in order to improve her credit. Name that credit union, I said:

Credit unions exist to serve precisely this kind of person: I simply don’t believe that any credit union would turn her away and deliberately send her to a usurious lender.

My second question was equally simple: what is the interest rate charged by the loan companies that Stand Up Missouri represents?

Well, Stand Up Missouri did get in touch with me — and offered to put me in touch not only with their CEO, Tom Hudgins, but also with the college professor in the video. That, in turn, set off an enormous number of emails and phone calls, where I talked at length with Stand Up Missouri, the professor in the video, and the CEO of her credit union. And frankly none of them come out of it looking all that great — although I have by far the greatest sympathy for the professor.

To put the standard terms of the debate into perspective, let’s turn to Jason Rosenbaum, of the St Louis Beacon:

“The question I have for people who are anti-payday loan — and I’m not pro-payday loan — is where are people going to borrow the money?” Lamping said. “Because somebody who needs to borrow $200 for 10 days, they need to borrow $200 for 10 days. If the demand for capital doesn’t go away, where do they get it?

“My answer is they’d probably go to the street,” Lamping added. “Or they have checks bounce and they have rent and utility bills shut off.”

Still disagreed, saying that people could use credit unions for small loans.

“There are too many (payday) lenders on every corner,” Still said. “People just get the impression that it’s easy money. People need really, really to evaluate whether they are in the position to pay back a loan. And they can go to a credit union. It will take a little effort, they’re not on every corner. But options are available for people that do not put them in this debt trap that they can never get out of.”

But the fact is that credit unions aren’t always wonderful places where you can waltz in and get a low-interest-rate loan which is clearly superior in all respects to what payday lenders and loan companies offer. Some of them are. But some of them aren’t.

The professor — I’m not using her name because it’s not fair for this story to be the most important thing about her as far as Google is concerned — is a longstanding member of Missouri Credit Union in Columbia. That’s her bank: it’s where she has her checking account, deposits her paycheck, everything. And it has been ever since she moved to the state fifteen years ago. You couldn’t ask for a more auspicious setup.

And when I first spoke to Hal James, Missouri CU’s CEO, he was clear about its policies. “We always try to make the loan,” he said: “I can’t imagine anybody in 30 years has told somebody to go to a loan company. It makes no sense to do that.”

James said that in no case would a low credit score disqualify a potential borrower from getting a loan: while the credit union does use credit scores in its underwriting, it does so only to set the term and the interest rate on its loans, and not to determine whether or not the loan should be extended in the first place.

But there were a couple of hints, too, that it wasn’t quite as simple as all that. “Signature loans are unsecured, we don’t promote those too much,” he said at one point. “We try and make sure to understand what the member’s asking for and what they want.” Later, he talked quite a lot about how the credit union’s procedure, where loans get escalated at least twice if they can’t get made on an initial pass, was reliant on the borrower having completed an application.

I then spoke to James a second time, after he’d had the opportunity to talk to the professor earlier this week. She’s still upset at the way that she was treated at the credit union, and there are a lot of discrepancies in their respective accounts. But it became increasingly clear to me that if you have bad credit, Missouri Credit Union is actually rather unlikely to give you a loan — even if you’re a long-time member in good standing.

The simple fact is that some lenders are more conservative than others, and James struck me as an extremely conservative lender. He doesn’t like making unsecured loans to people with bad credit — he’ll nearly always prefer to look at the person’s cashflow situation, and try to work on that instead. Maybe put together a budget, or a savings plan; maybe consolidate existing outstanding debt which was extended at high interest rates and free up cash that way.

I asked James if he had any kind of a product which would help people with bad credit improve their credit; he said no. “We help them build savings to cover short term needs,” he told me, adding that “we try to stay away from even overdraft protection.”

Instead, James works on changing “poor management of money that they’ve got”. The credit union, he said, will “work to get the savings started”, rather than add more debt: “if you think that you have to borrow more money to improve your credit score, that’s not a solution. It’s not going to work.”

Sadly, James is wrong about this. The information going in to your credit score includes absolutely nothing about your salary, or your savings rate, or any of your assets. Let’s say that I defaulted on a lot of loans five years ago, which ended up being charged off; since then, I’ve avoided all credit, got a high-paying job, lived within my means, built up my savings — and inherited a million dollars to boot. What happens to my credit score? Very little. As the bad loans on my credit report drift ever further into the past, they will have a slightly less negative effect on my credit score. But without anything positive on there, my score will remain abysmally low indefinitely.

James told me that “you can go from 500 to the mid-600s if your bad credit drifts far enough behind you”. I checked this with FICO, and it’s just not true. Once you have a bad credit score, the only way you can make a significant improvement to it is to borrow money and pay it back. The advice the professor says that she was given at the credit union was, in that sense, entirely accurate. And if the credit union wasn’t going to lend her the money she needed, then she really was left with only one alternative. She went to World Finance, and got the loan she needed.

I’m not entirely clear on what the interest rate was on that original loan. Right now, the professor is on her second loan with the company — a $3,000 loan which she’s repaying at $225 per month for 18 months. That means she’s going to repay $1,050 in simple interest over 1.5 years, or $700 per year, which works out to an interest rate of about 23%.

But simple interest is not the same as APR. Calculating the APR on an amortizing loan is non-trivial, because the principal amount is constantly shrinking, which reduces the denominator and therefore increases the interest rate. Happily, the internet can come to the rescue: if you plug in a $3,000 18-month loan at $225 per month into this calculator, it will tell you that the APR is 40.4%.

Which, I can tell you, is a number World Finance seems very keen to hide.

Is it a good idea for the professor to be taking out loans at 40% interest rates? Really, she didn’t have much of a choice. She needed the money, she got precious little help from her credit union, and the loan company was friendly and extended her the cash on terms she could afford.

What’s more, the professor’s relationship with World Finance has indeed improved her credit. Since taking out that first loan, she’s obtained two different credit cards, and also bought a brand-new BMW with 2.9% financing. All with essentially no help at all from her primary financial institution, which is Missouri Credit Union. The debt the professor is taking on may or may not be wise, given her unique individual circumstances. And the credit union could in theory be a valuable resource in terms of helping her work out whether, for instance, she can really afford that car. But the relationship there is broken, and I see no chance that it will be fixed.

James does admit that he let the professor down: “I think we did fail her,” he says, “and I don’t think we did what we should have done.” The credit union dropped the ball with respect to her loan application, which was left in limbo when she was in a time of need. But at the same time, he also admitted to me that the credit union would not have given her the unsecured loan she was looking for.

The professor’s credit score is now good enough that she qualifies for a mortgage; it wasn’t before. That’s the kind of help a credit union should be able to give, and it’s disappointing that Missouri Credit Union doesn’t seem to be able to bring itself to do that. If the professor (a) wanted credit and (b) wanted to improve her credit score, then the loan company was, sadly, the place she needed to go.

Which brings me to Stand Up Missouri, the lobbying group representing such lenders. They’ve been promising me information on the interest rates they charge for a couple of weeks now, which is information you think they would have to hand. But nothing yet: I’ll let you know if and when I get anything from them.

I did however speak to Stand Up Missouri’s CEO, Tom Hudgins; I don’t think anybody on the call would say that the conversation went particularly well. The key question here, of course, is interest rates: should they be capped, and if so, where. Hudgins is very keen on distinguishing loan companies from payday lenders, so I started with the payday lenders, who charge interest rates north of 400%. Do those loans count as predatory? No, he said: “I do not think that the payday loans in Missouri fall into that category.” The only loans he would characterize as predatory were illegal or unregulated loans.

But Hudgins also wanted to make the point that when you’re talking about short-term loans with a term less than one year, the APR can be a bit misleading: Stand Up Missouri likes to use the example of someone borrowing $100 today, paying back $101 tomorrow, and therefore paying an APR of 365% on their $100 loan.

OK, I said: if APR isn’t a good metric to use when judging how expensive a loan is, what is a good metric to use? Hudgins suggested that what we should do instead was look at the total amount of interest paid, in dollars, per $100 borrowed. That seemed like an interesting idea to me, so I asked him what would be reasonable, using that metric. “$15 per hundred,” he replied. “Is that a reasonable number? I would say that’s a reasonable number.”

I then asked Hudgins for an example of a loan from one of his companies, if they didn’t want to give me APR figures. He gave an example of someone who borrowed $500 for ten months, repaying the loan at $77.50 per month.

This confused me. The total repayment there is $775, which means the interest is $275, or $55 per $100 borrowed. And $55 is a lot more than $15. (As for the APR, that works out at a whopping 106%.)

So Hudgins gave another example, where somebody borrowing $100 repaid $125 over a shorter time period. But that’s still well over $15 per $100 borrowed.

Eventually, Hudgins declared that it’s not the total interest that we should be looking at, but rather the monthly interest. Borrowers, he said, shouldn’t have to pay more than $15 per $100 per month. At which point my jaw kinda hit the floor, the call came to a bit of a messy conclusion, and Stand Up Missouri’s spokesman sent a follow-up email:

I’m afraid Tom didn’t quite get the math right on the call. To be honest, it makes more sense on paper than in a conversation. I hope you will afford us the opportunity to provide you with the numbers / data for Missouri before you cover this issue again.

That was on December 28, over a week ago; as I say, if the numbers do arrive I’ll happily publish them, but I’m not going to wait indefinitely for numbers which might never come.

It seems to me, then, that Missouri’s loan companies can actually serve an important purpose: they are willing to extend loans to people who need them and who can’t borrow that money elsewhere. And if you go to a loan company rather than a payday lender, you can significantly improve your credit score, too. I’m not happy about it, but this, from Stand Up Missouri’s FAQ, is actually true, a lot of the time:

Aren’t there “cheaper” alternatives to these traditional installment loans?

No. Because of the “high touch” relationship required in traditional installment loans, there are simply no other options that provide the same service and disciplined and responsible loan repayment terms.

At the same time, however, the loan companies do themselves no favors at all by being incredibly opaque about the terms on their loans and the interest rates they’re charging; I’d never actually recommend that someone go to such a shop, since the entire business model seems to be based on exploiting sophistication asymmetries and charging as much interest as possible.

So two things are needed here, I think. The first is effective regulation, with teeth; I hope that Richard Cordray, newly installed at the head of the CFPB, will start providing that soon. There’s no time to waste.

But regulation isn’t enough: we also need alternatives — non-predatory financial products which allow people with bad credit to repair that credit and get back on their feet. Many credit unions provide such products, but as we’ve seen, many credit unions don’t. And credit unions are in any case often difficult institutions to navigate: it’s never entirely obvious who’s allowed to join any given one. Can someone set up a Kiva for America? Help is needed, here. And it’s very hard to find.